Flash In The Pan

By William Davis

It’s likely that you first heard about high-frequency trading way back in 2014 when Michael Lewis published “Flash Boys”. In his book, the supremely talented Mr. Lewis described how high frequency traders, through the use of lightning-fast fiber optic lines, were taking advantage of investors by “front running” orders. Meaning they were buying ahead of us slow-pokes then selling back to us for a fraction more than they paid. Got it?

Peter: So we simplified the whole thing, and dropped the remainder into an account we opened.

Joanna: [Confused] So you’re stealing?

Peter: Ah, no, you don’t understand. It’s very complicated.*

Galactically enough, the once-lucrative business seems to be speed-circling the ol’ microwave dish these days. As a result of vicious infighting and algorithmically rising costs (think millimeter-wave and laser technology), HFT firms – which believe it or not account for around half of average daily volume in U.S. stock trading – have seen revenues plummet from $7.2 billion in 2009 to an estimated $1.1 billion last year. Got that?

Joanna: Oh okay. But you’re gonna’ be making a lot of money, right?

Peter: Yeah

Joanna: Right. And it’s not yours.

While high-frequency trading on its face seems like it should be illegal, HFT firms are doing little more than exploiting the system’s structural flaws. Truth is, the automated stock market is stunningly complex and there exists around it a shadowy layer of middlemen who profit from that complexity – a mysterious labyrinth of greedy souls that adds little actual value to the market or to the larger economy. So who cares if the flash boys aren’t as flashy as they used to be. From where we sit, they’ve taken something and added nothing. They’re only getting now what they deserve.

Peter: Well it becomes ours.

Joanna: And how is that not stealing?

Peter: I don’t think I’m explaining this very well.

*(Office Space, 1999)

What the markets have been doing…

With plenty to worry about this period, not least of which passage of a healthcare bill, traders mostly lost their enthusiasm for the buy side. Beyond the political mess, concerns over rate increases and the reflation trade added to the nervous mix, leaving stocks little where to go but down. In the middle of general declines for the major indexes across the two-week stretch, the S&P 500 posted its first single-day decline of 1% or more for the first time in 109 trading days.

Economic data provided little, if any, boost to investors’ sprits. Home sales reports were mixed for February, weekly jobless claims rose to a seven-week high, while durable goods orders rose a bit. So much for March Madness.

INDEX

Friday’s Close

Two-Week Point Change

Year-to-Date Change

DJIA

20596.72

-(306.26)

+4.22%

S&P 500

2343.98

-(23.74)

+4.70%

NASDAQ

5828.74

-(32.99)

+8.89%

Not unlike the equity side, Treasuries of almost all stripe finished lower, and without much enthusiasm. Investment-grades were also lackluster, with only a handful of new deals announced. The high-yield market also seemed to lack much conviction this period, though the asset class moved slightly higher over the period. Municipal bonds posted positive returns in line with Treasuries and the broader fixed income market.

FIXED INCOME

Period

YTD

12 Months

Yield

U.S. Treasuries

0.6%

0.7%

-(0.8)%

2.4%

U.S. Investment Grade

0.7%

1.1%

4.0%

3.3%

U.S. High Yield

-(0.2)%

1.8%

15.8%

6.1%

U.S. Municipals

0.6%

1.4%

0.4%

2.5%

What the pundits have been saying…

“Progress in reaching the central bank’s full employment and inflation objectives gives me confidence to be gradually and patiently removing accommodation. Raising short-term interest rates three times this year is a reasonable baseline.”

Federal Reserve Bank of Dallas President Robert Kaplan

“We don’t not need to much more to keep inflation in check. I’m okay with a second rate hike this year.”

Federal Reserve Bank of San Francisco President John Williams

“I think the economy is in a good place right now. Growth has been basically a little bit above trend. Raising rates three or four times this year makes sense.”

Federal Reserve Bank of St. Louis President James Bullard

What people have been saying…

“Avon is like a boat that’s been in the water for 130 years. You have to take it out and scrape all the barnacles off.”

Steven Mayer, an executive at private-equity giant Cerberus, which took over Avon’s failing North American business last year

What the numbers are saying…

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional. The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.